Friday, May 22, 2015

German macro morning, part 2. The future. German business confidence only gave in marginally, illustrating almost imperturbable optimism. Contrary to this week’s ZEW and PMI readings, Germany's most prominent leading indicator, the Ifo index, remained almost unchanged, dropping to 108.5 in May, from 108.6 in April. While the current assessment component improved to its highest level since May last year, expectations dropped to 103.0, from 103.5 in April.
With today’s GDP data, yesterday’s PMIs and now the Ifo, new doubts about the strength of the German economy could emerge again. In our view, any of these swan songs on the German economy are premature. However, it is simply a fact that Germany is at the end of a very positive reform-growth cycle, which is artificially extended by external tailwinds. In addition, given the long recovery the German economy has already gone through, it is only more than normal that growth rates at some point in time will be lower than in the rest of the Eurozone, which in turn has been suffering from weak growth now for several years.
In the short run, the fundamentals are sound enough to see another acceleration of the German economy. This is also reflected in today’s increase in the Ifo’s current assessment component. As orders at hand have increased again and inventories have dropped, industrial production should support growth in the coming months. Moreover, and probably even more important, the strong labour market, higher wages and low interest rates should further drive consumption and the construction sector. Finally, the weaker euro should continue to boost German exports. However, despite these sound fundamentals, some volatility might lay ahead. As public holidays and bridge days could reduce working days in May to a possibly record-breaking low of 17 days, some data distortion should be expected.
Looking ahead, and despite our optimistic outlook for the German economy, there are several risks, grouped into short- and long-term risks. In the short run, the in our view most important risks are: i) the never-ending Greek crisis, which despite latest rumors of some progress could still escalate and is clearly more dangerous and explosive than financial market participants seem to believe; ii) a longer-than-expected period of weakness of the US economy, which could affect German exports both through less demand and a further strengthening of the euro; and iii) a further escalation of what seems to be a new strike culture in Germany. Up to now, the economic impact from several strikes this year should have been very limited. But this could change. In the longer run, the lack of new reforms to further reduce unemployment, the current investment gap and the deficit in digitalization could eventually backfire on the German economy once the current favourable tailwinds like the weak euro, low energy prices and interest rates disappear.
All in all, today’s German macro morning was clearly not enough to cheer up real morning grumps. However, this morning’s data were also no reason to stay in bed and get depressed about the German economy. Maybe the economy is just human: it can’t deliver peak performances every month or every quarter.

Tuesday, May 19, 2015

Fear of heights or trend reversal? Today’s ZEW index shows that German investors have lost parts of their earlier optimism. In May, the headline index dropped for the second straight month to 41.9, from 53.3 in April. This was the strongest monthly drop since August last year. At the same time, the current assessment component dropped for the first time since October last year and stands now at 65.7, from 70.2 in April. Despite today’s drop, both components remain far above their historical averages.
German investors seem to be a bit confused. The positive trends of the first months of the year have been (partly) reversed over the last four weeks. The euro strengthened by more than 4.5%, oil prices increased by more than 6% and government bond yields have more than quadrupled. Moreover, the German stock market temporarily lost more than 6%, though it has recovered almost all of these losses in recent days. At the same time, the economy has struggled to match the optimism illustrated by buoyant consumers and business confidence indicators.
In our view, there are still very few arguments in favour of changing our positive take on the German economy. In fact, even if the external tailwinds have subsided somewhat, they are still there. Just to put latest developments into perspective: compared with their average value of the last 12 months, bond yields are currently still some 20bp lower, the euro some 10% weaker and oil prices almost 30% cheaper. Still sufficient to give the economy a cool breezy boost. Moreover, domestic fundamentals remain sound and particularly consumption should support growth in the coming months.
Looking ahead, there are currently three major risks for our optimistic outlook for the German economy: i) the never-ending Greek crisis, which despite latest rumors of some progress could still escalate and is clearly more dangerous and explosive than financial market participants seem to believe; ii) a longer-than-expected period of weakness of the US economy, which could affect German exports both through less demand and a further strengthening of the euro; and iii) a further escalation of what seems to be a new strike culture in Germany. Up to now, the economic impact from several strikes this year should have been very limited. But this could change.
In our view, today’s ZEW correction is not the beginning of a trend reversal and no reason to become concerned about the German economy. It is rather a sign of acrophobia and a return of realism.

Tuesday, May 12, 2015

The German statistical agency just released the first estimate of first quarter growth. The Eurozone’s largest economy grew by 0.3% QoQ in the first quarter, from 0.7% QoQ in the final quarter of 2014. On the year, GDP growth is 1.1%, from 1.6% in Q4 2014. GDP components will only be released at the end of the month, but according to available monthly data and the statistical agency’s press release, growth was mainly driven by domestic factors. While private consumption, government spending, investment and above all the construction sector contributed positively to growth, new exports should have been a drag.
The story has been written now so many times. The German economy is still benefitting from earlier reforms, which are now artificially extended by external tailwinds, mainly caused by the ECB’s QE. The more provocative question German policymakers should start to ask is why is the economy growing faster?
Pushed by job security, higher wages and low interest rates, Germans have finally started to consume; exports, supported by the weak euro, are again fast-selling items with the current account surplus reaching new record highs almost every month; and public revenues exceed expectations year by year. Against this background, today’s 0.3% QoQ could even be called weak.
In our view, there are at least three missing links to an even stronger recovery: the labour market, investment and public finances. In fact, the labour market seems to have reached a level of full employment. New structural reforms would be needed to push unemployment below the level it has now been fluctuating around for two years. As regards investment, except for the construction sector, industrial production has moved rather horizontally for almost four years. This is either reflecting a structural change in the economy, where industrial production has become less important, or it is showing the need for more domestic investment. Finally, the strong performance of public finances is positive for the future of an ageing economy and society but at the current level of interest rates might not be the choice to tackle weak investment.
All in all, today’s GDP data confirms the ongoing solid performance of the Eurozone’s largest economy. It also confirms our call of 0.4% GDP growth QoQ for the Eurozone (to be released at 11am CET). However, as witnessed in yesterday’s soccer Champions League semi-final: a solid performance is not (always) sufficient to stay at the top. As Bayern Munich will probably now discuss new investments in its current squad, the German government should do the same for its economy.